2019/98 Supported by K NKONW A A WELDEGDEG E OL N ONTOET E S ESREI R E ISE S F OFRO R P R&A C T HTEH E NEENREGRYG Y ETX ITCREA C T I V E S G L O B A L P R A C T I C E THE BOTTOM LINE Ensuring That Regulations Evolve as Mini Grids Mature As they mature, mini grid sectors evolve from marginally viable competitive entrants to potential Why is this issue important? energy. Without regulation, their monopoly position may allow them to raise their tariffs too freely. monopoly providers of essential Regulations that evolve with the mini grid sector can Although a fully integrated power system remains the most services. In early stages, overly achieve policy objectives (such as rapid electrification) efficient electrification solution for most countries, mini grids have stringent regulation can choke while protecting consumer interests an edge over main grid expansion as a means to rapid electrification. the sector’s growth. In later Because they can attract private financing and be deployed quickly, stages, however, closer regulation The timing and depth of economic regulation are key to the develop- mini grids can help countries transition toward full integration in is usually necessary to protect ment of mini grid sectors. The two pillars of regulation are (i) “setting, remoter regions, where the main grid is unlikely to arrive in the customers. Regulators can manage monitoring, and enforcing maximum tariffs,” and (ii) establishing medium term, thus providing earlier access to many more people.2 the regulatory evolution required “minimum service standards” (Brown and others 2006: 5). The recent emergence and growth of mini grids in a handful of of this sector by defining its Mini grid sectors grow through three stages. Stage 1 is startup. countries has drawn the attention of policymakers and regulators. growth phases and spelling out, in At this point, the sector consists of a handful of commercially viable In their efforts to increase social welfare and protect consumers, advance, the regulations that will mini grids serving relatively few customers. Growth occurs in Stage governments are looking into how to regulate mini grids to ensure apply at each stage. 2, as the sector replicates existing business models and creates reliable service at the lowest tariff. Some jurisdictions, such as Uttar new models to serve more customers. Localized market dominance Pradesh in 2016, have adopted regulations specific to mini grids. is Stage 3. In this stage, mini grids are seen to be dominating their Rural electrification agencies are setting up technical assistance and local energy markets.1 This three-stage maturation process requires subsidy programs to develop mini grids in rural areas and control sensitive regulation keyed to the different stages. their costs. For example, in Nigeria, the Rural Electrification Agency During the startup and growth stages, when mini grids are enter- aims to provide developers with a database of potential sites and ing the market and growing, light regulation is generally sufficient. with connection subsidies. Because they are operating in remote regions, where the main grid is Mini grid sectors are flourishing in many countries thanks to unlikely to expand soon, mini grids face competition from traditional innovative business models coupled with cost and performance energy sources. This competition incentivizes mini grids to offer improvements in renewable and storage technologies. In Nigeria, better service at lower tariffs, which reduces the need for regulation. the government plans to develop ten thousand mini grids by 2023 When mini grids become dominant in their respective markets, however, governments may want heavier regulation to ensure good This Live Wire was prepared by the levels of service at the lowest tariff. Mini grids may gain market 2 To meet Sustainable Development Goal 7 on universal access to clean and sustainable Global Facility on Mini Grids, a program energy by 2030, an estimated 440 million people would need to be connected to mini grids power in the energy market as they replace traditional sources of (IEA 2017, figure 2.5). The 440 million figure is calculated based on the following data in IEA of the World Bank’s Energy Sector (2017): 150 million new mini grid connections under the New Policies Scenario (business as Management Assistance Program usual scenario); 290 million additional connections under the Energy for All scenario (based on 1 (ESMAP). “Market dominance” in this context refers to a mini grid that is providing an essential service 670 million people lacking electricity by 2030, and 40 percent of them served by mini grids as in an area from which alternatives have been driven out. lowest-cost technology). 2 E n s u ri n g T h at R e g u l ati o n s E v o l v e a s M i n i Gri d s M at u re (REA 2017). Most of the mini grids being developed today in the mini grids in that they enable people to use appliances that would World Bank’s client countries are solar hybrids—solar photovoltaic otherwise be powered by electricity. Kerosene lamps provide light (PV) systems coupled with battery storage and backed up by a at night; car batteries power radios. Entrepreneurs have established diesel generator. The costs of such systems have plunged over the phone-charging centers running on diesel generators or solar panels. past ten years (IRENA 2016: 4), displacing diesel-based systems that In this competitive market, mini grids’ tariffs cannot exceed Mini grids usually take have long been used in the same off-grid environments. Operators households’ willingness to pay. When a mini grid enters a market, it root in communities have set up attractive business models that rely on service equal often cannot charge more per month than what households were to or exceeding that offered by the main grid (where the main grid spending on the energy sources the mini grid is seeking to replace. lacking an electricity grid. is available), accompanied by convenient payment options, such as Although mini grids can offer a higher level of service than But these communities mobile money. traditional sources of energy, enabling households to run a fan, a have access to other The challenge is to design a regulatory framework that promotes fridge, a TV, or a computer, people in low-income communities may sources of energy— good service at the lowest cost-recovery tariffs throughout the not own such appliances or be able to afford the energy required to sector’s three stages of development. Such a regulatory framework run them.On balance, however, incipient mini grids increase social kerosene, car batteries, needs to be flexible enough to evolve while maintaining predictability welfare by supplying electricity more efficiently than traditional or diesel self-generators. for developers. sources of energy. They offer better service than these sources, at In this competitive market, the same or lower cost. Figure 1 shows the difference between the mini grids’ tariffs cannot Why should regulations evolve with mini grid sectors? monthly cost of electricity from mini grids (dark blue bars) and the monthly expenses of nonelectrified households on energy consump- exceed households’ Evolutionary regulation can mitigate the risks tion that can be replaced with electricity (that is, excluding energy willingness to pay. inherent to each stage of the mini grids’ trajectory by for cooking) in Bangladesh, Cambodia, Kenya, Nigeria, Tanzania, and keeping development costs low in incipient markets Uttar Pradesh (India). The difference can be as much as 4–12 percent and protecting customers in mature ones of these countries’ monthly GDP per capita. Mini grids in remote areas face high development costs. It is An evolutionary regulatory approach would allow mini grids expensive to bring in equipment and staff over rugged road systems. greater initial freedom, becoming more stringent as they gain market New mini grids struggle to recover these costs, and they are already power. A light approach in an early stage recognizes that whereas constrained in their pricing by limited budgets and the prices of some regulation may be appropriate and even help attract investors traditional sources of energy. (for instance, by answering questions about what happens when the In a market characterized by such nascent mini grids, regulation grid arrives), conventional regulation of tariffs and service standards can stifle investment. For that reason, a light approach may be more may impose costs and reduce flexibility, making it harder for mini appropriate. Overregulation can undermine the commercial viability grids to get established. Regulation can start to put upper limits of incipient markets in three ways: on tariffs and lower bounds on service standards once mini grids • By setting tariffs too low to allow the developer to recover costs begin to gain market power and become a dominant supplier of an • By setting excessive service and technical standards, thereby essential service. raising the developer’s costs too high The startup and growth phases. Mini grids usually take root • By increasing startup costs—that is, costs incurred in reviewing in communities lacking an electricity grid. But these communities the regulatory framework, acquiring authorizations, or negotiat- have access to other sources of energy—kerosene, car batteries, ing contracts. or diesel self-generators. These sources of energy compete with 3 E n s u ri n g T h at R e g u l ati o n s E v o l v e a s M i n i Gri d s M at u re Figure 1. Comparison of household spending on electricity from mini grids and on other energy sources spending on electricity from mini grids (2017) spending on energy services in unelectrified areas Bangladesh Kerosene, battery, cell phone charging (2014) Mini grids increase social Kerosene, car battery (2013) welfare by supplying electricity more efficiently than traditional sources of Cambodia Kerosene, battery, cell phone charging (2014) energy. They offer better Kerosene, car battery (2008) service than these sources, at the same or lower cost. Kenya Kerosene, battery, cell phone charging (2016) Kerosene, battery, candles, cell phone charging (2015) Nigeria Kerosene, battery powered torches, cell phone charging (2017) Kerosene (2012) Tanzania Kerosene, dry cell battery, cell phone charging (2017) Kerosene, cell phone charging (2014) Uttar Pradesh (India) Kerosene, cell phone charging (2015, Pipargaon village) Kerosene, cell phone charging (2015, 17 districts of the state) 0 2 4 6 8 10 12 US$ per household per month Notes: The labels to the right of the bars describe the energy products households consumed during the year indicated. For Cambodia and Kenya, the sources include electricity in households’ con- sumption of energy. This is consistent with an approach to analyze the consumption of nonelectrified households, since these electrified households lack availability and quality of supply and must compensate with other energy products. 4 E n s u ri n g T h at R e g u l ati o n s E v o l v e a s M i n i Gri d s M at u re Even as mini grid markets develop, regulation is not always Mini grids under 100 kW of installed capacity are subject to registra- appropriate. Even as mini grids gain market power, they may still tion that leaves them freedom regarding location and tariff setting; be struggling to compete against solar home systems. In addition, those above 100 kW must apply for a permit that requires proof that competition between mini grid providers for unelectrified villages the area requested for service is actually unserved, calculating tariffs may develop (Greacen, Nsom, and Rysankova 2015). following the regulator’s cost-plus methodology; those above 1 MW By spurring productive The localized market dominance phase. At some point, must apply for a license. growth in their community, however, successful mini grids gain market power in their communi- mini grids enable new ties, driving traditional sources of energy out of the market as people How should regulations evolve as mini grid become dependent on electricity provided by the mini grid. This is a businesses to develop as sectors mature? good thing: By spurring productive growth in their community, mini households and businesses grids enable new businesses to develop as households and busi- Tighter regulations should be triggered by defined come to rely on computers, nesses come to rely on computers, telecommunications, and other transitions between the stages of development of services that require larger quantities of always-on power. Kerosene mini grid sectors telecommunications, and car batteries will not be able to meet demand. Residents would and other services that in any case not revert to the inconvenience of kerosene or to carting Evolutionary regulation combines flexibility with predictability for require larger quantities of their electricity home in a battery. investors. Predictability, of course, allows investors to make plans But once mini grids gain excessive market power, tighter based on expected revenues. In Cambodia again, the regulator always-on power. Kerosene regulation may well be warranted to limit the operators’ ability to modified the regulations governing mini grids after the market and car batteries will not charge prices above full cost (including reasonable profits) and collect evolved, but without planning for it. This forced investors to adapt to be able to meet demand. the changes as they were being implemented and caused them to monopoly rents at the expense of consumers. At this stage, too loose a regulatory framework can lead to costly and even less-reliable service worry about their ability to sustain investments. In 2016, Cambodia’s (if the operator no longer feels compelled to maintain the system). regulator adopted a national uniform tariff below mini grids’ cost-re- Cambodia’s regulatory framework evolved alongside changes covery tariff, thinning distribution margins despite subsidies issued in its own mini grid sector. Cambodia gradually began regulating its through the main utility’s budget. mini grid sector in 2001, after a period of laissez-faire. The Electricity One way to ensure regulatory predictability for investors while Law of 2001 requires mini grids to obtain a license, charge tariffs allowing regulation to evolve is to define the regulatory stages at the approved by the regulator, and meet service and technical standards. outset, setting thresholds for transitions from one stage to the next. The regulator incentivized mini grids to comply with the standards With the help of table 1, the text that follows suggests three phases and extend service by giving longer licenses to those that made and two thresholds for regulation of market entry, tariffs, service progress and by allowing tariffs to cover the investments required standards, technical standards, and subsidies. to upgrade their distribution systems. In parallel, the government At the outset, when a mini grid operator enters the market, only distributed subsidies. This approach succeeded in increasing light regulation need apply. In the entry phase: the number of mini grids from 130 in 2006 to some 340 in 2016 • The regulator requires only registration, since more burdensome (Electricity Authority of Cambodia 2007, 2017). regulation, such as permitting or licensing, may hinder market Nigeria adopted a multi-tier framework that differentiates entry. between small and large mini grids. This framework allows develop- • The regulator allows mini grids to set their tariff freely, under a ers to know what will trigger a change in the applicable regulatory “willing buyer, willing seller” regime. regime—in this case, the size of the mini grid’s installed capacity. 5 E n s u ri n g T h at R e g u l ati o n s E v o l v e a s M i n i Gri d s M at u re Table 1. Evolutionary regulation in three phases Regulatory issue Startup Growth Localized market dominance Market entry Registration Registration Permit/license Tariff Willing buyer, willing seller Price cap defined with reference to Individualized cost-based tariff costs of “efficient new entrants” One way to ensure Service standards Reporting Differentiated regulated standards Grid level standards regulatory predictability for Technical standards Safety standards Safety standards Safety standards Optional grid-compatible standards Optional grid-compatible standards Optional grid compatible standards investors while allowing Subsidies Implicit subsidies (information, land, favorable tax treatment) Capital cost subsidies, and/or Connection subsidies, and/or regulation to evolve is Optional capital cost subsidies connection subsidies energy subsidies to define the regulatory Threshold 1 might be defined as being reached, say, five years after first mini grid was registered, once a set number of customers had been reached, and once average power consumption per customer had reached a certain level for the majority of mini grids (e.g., 40 percent of average main-grid consumption). stages at the outset, setting Threshold 2 might then occur some 10 years later, once another set number of customers had been reached, and once average power consumption per customer had reached a specified higher thresholds for transitions level for the majority of mini grids (e.g., 80 percent of average main-grid consumption). from one stage to the next. • The regulator does not set service standards, limiting the regu- and phone-charging in areas served by mini grids, or average power lation of technical standards to issues of safety and grid-com- consumption per household (for example, 40 percent of average patibility (and, to limit upfront costs, enforcing these only when main grid household consumption). mini grids move to connect to the main grid). Competition from In the growth phase—when existing mini grids are gaining traditional energy sources incentivizes mini grids to offer better market power and more are coming online—regulation of tariffs and and safe service. service standards kicks in. In the growth phase: • The government need not provide significant subsidies, given • Entry regulation still need be no more than simple registration, that light regulation is already saving developers money. The because tariffs and standards can be imposed through regulation government may consider implicit subsidies3 and possibly without the need for greater control over entry. viability-gap subsidies if customers are not willing and able to • The regulator may consider capping the tariff. The cap would set pay a cost-recovery tariff. Implicit subsidies reduce capital costs a single benchmark tariff for all mini grids at a level estimated to without direct funding, for example, through tax exemptions; be the cost of service of an efficient new entrant in the business. capital-cost subsidies provide a known amount of funding early • The regulator may consider setting minimum service levels but in the life of the project to close part of the equity gap. leave the regulation of technical standards unchanged, since changing the latter would oblige mini grids to rebuild their The transition from startup to growth may be triggered by one systems to different standards, with attendant costs. or more criteria, possibly the number of years since the first mini • The government may choose to provide capital-cost and grid is registered (for instance, five) or market-penetration statistics connection subsidies. These would help mini grids comply with for registered mini grids. Market penetration may be measured by tariff and service-standards regulation and expand the market. indicators such as number of customers reached by all mini grids Connection subsidies enable households to connect to mini grids compared with the total population of all communities served by by funding the shortfall between their willingness to pay and the mini grids, the market share of mini grid electricity used for lighting cost of connection. 3 An implicit subsidy is a subsidy that is not a cash transfer. Implicit subsidies range from tax breaks to the provision of land, technical assistance, or information. 6 E n s u ri n g T h at R e g u l ati o n s E v o l v e a s M i n i Gri d s M at u re The transition from the growth phase to the localized market In sum, how does evolutionary regulation foster the dominance phase may be triggered by criteria similar to those development of mini grid sectors? applied in the first transition, but at higher levels—for instance, 15 years after the first mini grid is registered, or 95 percent market It protects customers while giving investors certainty share for lighting and charging services in areas served, or average and predictability Evolutionary regulation consumption per household at 80 percent of average main-grid Evolutionary regulation protects customers from the risks they face offers investors household consumption. at different stages of development of the mini grid market. At the In this long-term phase, regulation of tariffs and service stan- predictability and a start, light regulation may suffice, as customers face few risks. To dards may be further tightened: measure of certainty. attract customers, mini grids are obliged to offer better service at the • The regulator uses individualized, cost-based tariff limits, since same or lower prices than traditional energy sources. Light regulation Developers know how an efficient-new-entrant price cap can leave a degree of monop- allows mini grids to develop rapidly and efficiently in a low-cost, they will be regulated at oly pricing. nonintrusive regulatory environment. Mini grids can adapt their ser- • The regulator may opt to require grid-level service standards to each stage of the sector’s vice offerings and prices to the market. As mini grids gain localized ensure that service for all customers is equal. development because the market power, heavier regulation is introduced to protect customers; • Mini grids may not need capital-cost subsidies to develop in new tariffs are kept at cost-recovery levels and service is maintained at regulatory regime in each communities. But the government could continue to provide reliable and good-quality levels. phase, and the trigger for connection subsidies for low-income customers to connect to Evolutionary regulation also offers investors predictability and a mini grids. In addition, the government could decide to provide moving from one phase to necessary measure of certainty. Developers know how they will be energy subsidies if it sought to reduce the cost of electricity for another, is defined. regulated at each stage of the sector’s development because the all mini grid customers; alternatively, it could choose to align mini regulatory regime in each phase, and the trigger for moving from one grid tariffs with those of the national grid. Energy subsidies are phase to another, is defined. But defining phases of regulation and those provided per kWh delivered, so they lower energy costs for triggers for transition is not enough in itself. A government needs to customers; they are not paid upfront. commit to following through with the plan, abstaining from regulating until the trigger is reached, and regulating as planned thereafter. A similar model, applied on a per-mini grid basis, provides a To succeed, evolutionary regulation requires significant resources grace period devoid of any regulation (Tenenbaum and others 2014: from regulators, developers, and customers. Designing and enforcing 320–22). If an operator were to seek an extension of the grace a regulatory regime that will be relevant ten years from now, one period, the regulator would conduct a review to consider extending that is both flexible and predictable, requires substantial regulatory the grace period or moving a mini grid into the regulatory regime. The capacity. grace-period model is simpler than evolutionary regulation, but the path it provides is not as well tailored or predictable. 7 E n s u ri n g T h at R e g u l ati o n s E v o l v e a s M i n i Gri d s M at u re References IEA (International Energy Agency). 2017. Energy Access Outlook 2017: MAKE FURTHER Brown, Ashley, Jon Stern, Bernard Tenenbaum, and Defne Gencer. 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Uttar Pradesh Mini-grid Policy and significant contributions from the team of Castalia Strategic Advisors, and Greacen, Stephanie Nsom, and Dana 2016. http://upneda.org.in/sites/default/files/all/section/Mini%20 specifically David Ehrhardt, Gianmarco Servetti, Lisa Tessier, Charly Missirian, and Rysankova. Laurie Hervot. Their support is gratefully acknowledged. The GFMG is a program Grid%20Policy%202016.pdf. of the World Bank’s Energy Sector Management Assistance Program (ESMAP). The Live Wire 2017/76. “Increasing the Greacen, Chris, Stephanie Nsom, and Dana Rysankova. 2015. “Scaling Facility helps mainstream mini grids into World Bank lending projects and national Potential of Concessions to Expand Up Access to Electricity: Emerging Best Practices for Mini-Grid electrification programs and supports the development and dissemination of Rural Electrification in Sub-Saharan knowledge and learning on mini grids. To share and exchange the latest develop- Regulation.” Live Wire 51, World Bank, Washington, DC. http://hdl. Africa,” by Richard Hosier, Morgan ments, the GFMG hosts annual Action Learning Events. Bazilian, and Tatia Lemondzhava. handle.net/10986/23137. Live Wire 2017/86. “Data as an Enabler in the Off-Grid Sector: Focus on Tanzania,” by Christopher Arderne, Yann Tanvez, and Pepukaye Bardouille. Live Wire 2019/97. “Investing in Mini- Grids Now, Integrating with the Main Grid Later: A Menu of Good Policy and Regulatory Options,” by the Global Facility on Mini Grids. Find these and the entire Live Wire archive at https://openknowledge. worldbank.org/handle/10986/17135. 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